New RBI governor Raghuram Rajan steps into the heart of the rupee storm

Raghuram Rajan, a suave, unflappable University of Chicago economist, stepped into the heart of the storm roiling India's economy on Thursday as the Reserve Bank of India's new governor and chief defender of a nose-diving rupee.

The currency has plunged nearly 20 per cent since May as Asia's third-largest economy confronts its worst crisis since 1990-1991. The government's piecemeal efforts to stabilise the rupee have done little to halt its steep slide. It has tumbled about 10 per cent alone since Rajan's appointment on August 6.

Rajan has few policy options to revive the rupee but one thing he can do immediately is explain to financial markets more clearly what steps the central bank is taking and the thinking behind them. Investors and economists have complained that the bank has caused unnecessary confusion with some pronouncements.

The big question is whether the former chief economist of the International Monetary Fund (IMF), who famously predicted the 2008 global financial crisis, will take the helm of the Reserve Bank of India with a whisper or a bang. In other words, will he take his time or come out with fresh policy announcements like Bank of Japan Governor Haruhiko Kuroda, who launched a massive stimulus package within weeks of taking office earlier this year.

Another pressing concern for markets is whether Rajan plans to dismantle any of the mishmash of measures, including a hike in short-term interest rates, the central bank has unveiled since mid-July to prop up the rupee. Economists have expressed concern the steps could further damage the ailing economy.

Rajan, aware markets are scrutinising everything he says for clues about his intentions, has been circumspect in public, revealing little about whether he will pursue the policies of his predecessor, Duvvuri Subbarao, or change tack.

Either way, economists expect him to hold fire with any major measures until after the US Federal Reserve meets on Sept 17-18, when it might announce a pivotal shift in its stimulus programme.

Keen to lower unrealistic hopes of what he can achieve, Rajan has stressed that he has no "magic wand" to solve India's multiple economic ills. The country has the world's third-largest current account deficit of about $90 billion, high inflation and an economy projected by private economists to grow at about 4 percent this fiscal year, half the rate it was in 2008.

"Economic policymakers require an enormous dose of humility, openness to various alternatives (including the possibility that they might be wrong), and a willingness to experiment," Rajan wrote in a column on the Project Syndicate website on August 8.

"ROCK STAR ACADEMIC IMAGE"

Rajan is a distinguished academic and author of the prize-winning book "Fault Lines: How Hidden Fractures Still Threaten the World Economy". He gained fame with a 2005 paper at a US meeting of central bankers, warning that financial sector developments could trigger an economic crisis.

Rajeev Malik, an Indian-born economist at CLSA Singapore, fears Rajan's "rock star academic image" could be a hindrance. "That is because it has generated unrealistic hope that he has some magical prescription to fix our problems," he wrote in the Business Standard newspaper on Tuesday.

Rajan will swap his first floor office in the splendid red sandstone British colonial building that houses the finance ministry in New Delhi for a view of the Arabian sea from the 18th floor of the central bank's Mumbai headquarters.

He will officially become the 23rd governor of the RBI after signing an oath of secrecy on Wednesday and will take charge operationally on Thursday.

In Delhi, policy-making can be a painfully slow process bedevilled by political intrigue but in Mumbai, Rajan will be in a faster-paced environment where his decisions will have a real-time impact on financial markets.

For the past year, Rajan, as chief economic adviser in the Finance ministry, has been an articulate champion of Chidambaram's efforts to curb India's fiscal deficit and has travelled with him to foreign capitals to try to woo investors.

Analysts expect Rajan to improve the central bank's communication with markets, which could help in restoring confidence among investors. Outgoing governor Subbarao has been sharply criticised for failing to communicate the central bank's exchange rate policy effectively.

The RBI has taken a series of extraordinary measures in recent weeks in a bid to curb speculative trades in the rupee. These have been cited as a key factor behind a slew of brokerage downgrades of India's growth forecasts since last month.

"One is tempted to say that if Mr Rajan can't help restore confidence in India's battered currency, nobody can," said Nicholas Spiro, managing director of Spiro Sovereign Strategy. "His immediate priority must be to restore credibility to Indian monetary policy which, over the past several weeks, has been a shambles."

PRO-GROWTH

Economists predict Rajan will prioritise currency stability over inflation and growth, at least initially, a Reuters poll showed last week.

Central bank officials privately say Rajan will have to continue Subarrao's strategy of draining cash from money markets, even though that has made it more costly for struggling corporates to raise money, putting another brake on growth.

Many economists say Rajan will refrain from taking action until after the US Fed meeting, which is widely seen announcing a tapering off in the bank's huge bond-buying programme. Those prospects have already sparked an investor exodus from emerging markets, including India, contributing to the rupee's fall.

He faces a dilemma on policy rates, which other hard-hit emerging market economies such as Brazil and Indonesia have raised to support their currencies. Doing so in India could undermine economic growth further - already running at a decade low - but cutting them could hit the rupee.

Outside the immediate steps to rescue the rupee, Rajan may pursue pro-growth policies.

In the government's economic survey published earlier this year, Rajan said it was imperative for India to revive growth to provide more decent jobs for the millions joining the labour force. At the same time, the government needed to bring down inflation and the fiscal and current account deficits, he said.

"Macroeconomic rigour may, in fact, lead to growth; cutting wasteful subsidies may reduce market distortions, shrink excess consumption and increase confidence about government finances, all of which can help growth, even in the short run," he wrote.

Rajan will join a central bank that is not statutorily independent from the finance ministry, but whose bureaucrats prize autonomy.

Rajan is seen as close to Chidambaram and the pair had adjoining offices in the Finance ministry "but he is a man of his own" stressed one policymaker who has been involved in recent meetings between the RBI and the ministry.

Finance ministry officials say Rajan will improve the coordination and communication between the government and the RBI. Under Subbarao the bank focused its efforts on curbing inflation, frustrating Chidambaram, who wanted the RBI to cut rates to boost the sluggish economy.

But the officials acknowledged that like his predecessor, Rajan would likely try to assert his independence. Before becoming Chidambaram's adviser, Rajan was sharply critical of the government for failing to drive ahead with economic reforms.

Rajan is expected to implement measures he recommended in 2008 while heading a committee on financial sector reforms, such as spinning off the debt management office and setting up a formal monetary policy committee.